Great Graphic: Base Money and Money Supply

Many observers continue to confuse base money with money supply. The Pragmatic Capitalism blog has been among the forefront explaining this distinction. The first Great Graphic here comes from a post on that blog from Niels Jensen of Absolute Return Partners. It shows the monetary base, which is what the central banks create when they purchase securities from dealers. This is depicted by the dashed lines. Bank lending is depicted with the solid lines. This is a helpful proxy for the conventional notion of money supply and it is the stuff that monetarists believe causes inflation. Bank lending is the primary way that the base money is converted into money supply. As the chart illustrate, the has been a clear breakdown of the transmission mechanism. The lower chart comes from the St. Louis Federal Reserve. It shows a particularly important and basic category of loans: commercial and industry loans. C&I loans are reported every week and this chart was updated on May 3rd. It shows that C&I loans in the US are approaching the previous cyclical peak. It lends credence to the view that the US and Europe have diverged. The US acted earlier and more aggressively to recapitalize the banks than Europe, for various and obvious reasons. Europe is also trying to address the too-big-to-fail problem, while the US has been moving slower and pursuing a different strategy. Remember, US banking system assets were less than 100% of GDP, while the banking assets of numerous European countries, including Germany and the UK, were some multiple of GDP. Hence the too-big-to-rescue (domestically) problem.